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Database Outside the EU, only Japan was able to generate comparably high R&D-intensity levels. Countries with a steady R&D percentage of GDP ranging from above 2 but below 3 percent are Denmark, France and Germany. Their average share is at a stagnating 2 to 2.5 percent. Comparably, the US shows a significantly higher R&D-level around 2.6 percent on average across the period of coverage. EU laggards in the development of R&D are Greece, Ireland and Italy, but also in Portugal and Spain. Their percentage share of R&D in GDP amounts to below 1.5 percent. The significant differences in R&D expenditures within the EU constitute the need for action if Europe wants to become the “most competitive and dynamic knowledge-base economy by 2010” (EU 2003). TRENDS IN R&D EXPENDITURES AND GOVERNMENT INTERVENTION The EU summits at Lisbon and Barcelona have emphasized the importance of a nation’s expenditures in research and development (R&D). This is due to the fact that R&D has been proven to be a crucial source to simulate economic growth and to foster employment in the long run. Policy makers are aware of the fact that there should be substantial contributions of innovations derived from private and public R&D to strengthen the competitiveness of firms and industries. Thus they have decided to increase the R&D intensity target of EU countries from 1.9 percent of GDP to 3 percent by 2010 (EU 2003). However, questions arise as to how R&D policies can stimulate private R&D activities or to what extent government spending on R&D might crowd out private investments. Regarding the 3-percent target the economic rationale for government involvement in R&D expenditures is more and more at the center of policy concern. For years economists have investigated the influence of public subsidies on private R&D expenditures. However, government policies to subsidize private R&D are limited by the notion that business Looking at EU-15 country trends in total gross doR&D projects usually generate a higher rate of remestic expenditure on R&D as a percentage of GDP turn than basic R&D. This weakens the justification since 2000, Table 1 reveals substantial differences beof public subsidies to private R&D compared with tween EU member states. It shows that only two counpublic funding of basic research. However, policies tries managed to meet the 3-percent target throughout designed to stimulate R&D investment levels should the period of coverage. Those countries are Finland ideally be based on the economic fundamentals of inand Sweden with 3.45 and 3.73 percent, respectively. centives for industry to invest in R&D as well as how R&D poliTable 1 cies can be best adapt to quickly Gross domestic expenditure on R&D as a percentage of GDP changing R&D environments. 2000 2001 2002 2003 2004 2005 2006 Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxemburg Netherlands Portugal Spain Sweden United Kingdom 1.91 1.97 2.24 3.34 2.15 2.45 n.a. 1.12 1.05 1.65 1.82 0.76 0.91 n.a. 1.85 2.04 2.08 2.39 3.30 2.20 2.46 0.58 1.10 1.09 n.a. 1.80 0.80 0.91 4.18 1.82 2.12 1.94 2.51 3.36 2.23 2.49 n.a. 1.10 1.13 n.a. 1.72 0.76 0.99 n.a. 1.82 2.23 1.88 2.58 3.43 2.17 2.52 0.57 1.17 1.11 1.66 1.76 0.74 1.05 3.86 1.78 2.22 1.87 2.48 3.45 2.15 2.49 0.55 1.24 1.10 1.63 1.78 0.77 1.06 3.62 1.72 2.43 1.84 2.45 3.48 2.12 2.48 0.58 1.26 1.09 1.57 1.74 0.81 1.12 3.80 1.76 2.49 1.83 2.43 3.45 2.10 2.53 0.57 1.32 n.a. 1.47 1.67 0.83 1.20 3.73 n.a. Japan United States 3.04 2.73 3.12 2.74 3.17 2.64 3.20 2.67 3.17 2.58 3.32 2.61 n.a. 2.61 Notes: Countries include EU-15, United States and Japan. Expenditures comprise business enterprises, goverment, higher education sector and private non-profit sectors. – n.a. = not available. Differentiating between the sources of funding of business enterprise R&D expenditures, Table 2 shows that most of business enterprise R&D is provided by industry itself, while government financing accounts for a substantially smaller share.1 This share ranges from less than 4 percent of industry R&D in Finland and Netherlands to nearly 14 percent in Spain in 2005. Italy and France both have similarly high government financing in business enterprise R&D in 2005 than Spain. 1 Further sources of funding as provided by the OECD database are other national funds and funds from abroad. Source: Eurostat (2008). 63 CESifo DICE Report 3/2009 Database support of industrial R&D but also by public sector research. Table 2 Business enterprise R&D expenditure by sources of funds in % of total funds Policy means intended to restore a socially desirable level of busiBusiness Government Business Government ness R&D focus primarily on increasing private returns from Austria 5.6b) 6.4d) 64.5b) 67.2d) Belgium 82.1 5.8 81.8d) R&D investments or attempt to 5.8d) Finland 95.4 3.5 90.9 3.8 cushion the negative conseFrance 81.0 9.9 80.7 10.1 quences from sunk costs. While Germany 90.8 6.9 92.1 4.5 Greece 85.7 5.6 increasing private returns aims to 90.5 a) 1.2 a) Ireland 89.1 3.3 86.1 4.1 internalize long-term gains from Italy 80.5 11.0 12.2b) 77.4b) private R&D investments by Luxemburg 97.5 1.6 n.a. n.a. c) c) protecting and strengthening inNetherlands 79.3 5.2 81.6 3.4 Portugal 90.8 4.2 91.4 4.2 vestors’ intellectual property Spain 86.7 7.2 79.9 13.6 rights through appropriate paa) a) Sweden 87.1 4.2 91.1 5.9 b) b) tent systems, the elimination of United Kingdom 69.7 8.8 63.2 7.1 negative consequences from sunk United States 91.4 8.6 91.5b) 8.5b) costs focuses on improvements of Notes: Countries include EU-15 except for Denmark and United States. – the fiscal environment. Subsidizn.a. = not available. – Data coverage: a) 2001. – b) 2002. – c) 2003. – d) 2004. ing risky R&D projects with tax Source: OECD (2009). incentives, for example, seeks to increase long-term rates of return Most of the EU countries exhibit a stagnating share and thus render R&D projects more profitable for inof government financing in industry R&D over time, vestors. Establishing appropriate tax systems for risk except Greece and Spain, which increased their govcapital operations within Europe therefore require ernment share dramatically from 2000 to 2005. On the harmonized tax transparencies as well as reductions other hand, Germany and the Netherlands cut back in tax obstacles to cross-boarder R&D activities (see their government R&D financing.The predominance EU 2003). in industrial funding as source of R&D efforts may T. S. be due to more efficient responses on the part of firms to changing market conditions and increasing competition on international factor markets. Reference 2001 2005 Arrow, K. (1962), “Economic Welfare and the Allocation of Resources for Invention”, in R. Nelson, ed., The Rate and Direction of Economic Activity, Princeton University Press, New York. The intention of governments to intervene and to direct R&D activities prompts a discussion of the justification of public intervention. The general argument for public support of R&D is well established on the grounds of market failure. Generally insufficient incentives hamper investments in R&D, which is why firms respond with socially suboptimal underinvestment. The reason for this is based on the public goods characteristics of innovations which generate lower private returns than its social returns (see, for example, Nelson 1959 and Arrow 1962). The argument of market failure has been further developed by introducing different types of market failure. These may arise out of the inability to fully capitalize on a firm’s own innovations due to unintended spillover effects to competitors, as well as confronting the investor with uncertainties and risks that need to be completely internalized. Hence, the scope for R&D policies has been widened by encompassing financial CESifo DICE Report 3/2009 EU (2003), Investing in Research: An Action Plan for Europe, Commission of the European Communities, Brussels, COM(2003) 226 final/2. Eurostat (2008), Database: Gross Domestic Expenditure on R&D, 1996–2007, as a Percentage of GDP, accessed 18 June. Nelson, R. (1959), “The Simple Economics of Basic Scientific Research”, Journal of Political Economy, 67, 297–306. OECD (2009), Database: Business Enterprise Intramural Expenditure on R&D (BERD) by Industry (ISIC rev. 3.1) and Source of Funds, accessed 28 July. 64